Accountant:

Accounting 540

Meeting:

XYZ Research Company

Topic:

Accounting Regulations and Treatment of Patents

Case Studied:

You have been hired as a consultant for XYZ Research Co. XYZ
Research Co. incorporated in 2010. XYZ s business centers on
developing new technology for interplanetary exploration. The
company has many patents and has historically expensed all of
the costs associated with obtaining their patents. The owners of
XYZ Labs are unsure whether or not if any or all of its patent
costs can be capitalized. They also are unsure if any impairment
testing should be done periodically on their patents. You have
been asked by the owners to look into these issues and provide
the appropriate accounting treatment for patents.

Purpose:

To research how the accounting is handled for Patents. Has XYZ

Company been accounting for these costs correctly or does
there need to be changes made to their accounting practices.
Can The cost to obtain a patent be capitalized? Also is
impairment testing required periodically on their patents? How
will this affect the financial reports?

Accounting Standards and Regulations

IAS 38 Intangible assets are non-monetary assets which are without physical substance
and identifiable (either being separable or arising from contractual or other legal rights). Those
meeting the relevant recognition criteria are initially measured at cost, subsequently measured at
cost or using the revaluation model, and amortized on systematic basis over their useful life,
unless the intangible has an indefinite useful life, in which it is not amortized.
IAS 38 requires an entity to recognize an intangible asset whether purchased or selfcreated at cost if, and only if it is probable that the future economic benefits that attributable to
the asset will flow to the entity and the cost of the asset can be measured reliably (IAS 38.21).
Additional recognition is required for internally generated intangibles; the probability of future
economic benefits must be based on reasonable assumptions about conditions that will exist over
the life of the asset (IAS 38.22). After initial recognition intangible assets should be carried at
cost less amortization and impairment losses. (IAS 38.74). An asset with an indefinite useful life
should not be amortized (IAS 38.107)

IAS 38.54 initial recognition of research and development (R&D) costs is charged to
expense. R&D costs are capitalized on after the asset is ready for use or sell. Research
expenditure is recognized in the income statement in the year in which it is incurred.
IAS 38.50 costs incurred in the development phase can be capitalized only if the
company can meet all of the following

Completing the asset so it will be available for use of sale

It has the intention to complete the intangible asset and use it in the business or sell it
The asset has the ability to be used or sold

Statement 142
This statement addresses the financial accounting for acquired goodwill and other
intangible assets and supersedes APB Opinion No 17 Intangible Assets. It explains how to
account for assets that have been acquired individually, or with a group of other assets, and how
they should be presented on the financial statements. Not included in the explanation are
intangibles acquired through a business combination.
ASC 350-30-35-1 A recognized intangible asset is accounted for based on it useful life to the
entity. An intangible with a finite useful life shall be amortized; one with an indefinite useful life
shall not be amortized
ASC 350-30-35-3 - The estimate of the useful life of an intangible asset to an entity shall be
based on an analysis of all pertinent factors, in particular, all of the following factors; the
expected use of the asset by the entity, the expected useful life of another asset or a group of
assets to which the useful life of the intangible asset may relate, and any legal, regulatory, or
contractual provisions that may limit the useful life. The cash flows and useful lives of intangible
assets that are based on legal rights are constrained by the duration of those legal rights.
350-30-35-18 - An intangible asset that is not subject to amortization shall be tested for
impairment annually or more frequently if events or changes in circumstances indicate that the
asset might be impaired.
ASC 350-30-45-1 All intangible assets have to be aggregated and presented in the financial
reports as separate items. However any individual intangible assets or classes must be presented
on a separate line item
ASC 350-30-45-2 - Amortization expense and impairment losses for intangible assets shall be
presented in the income statement within continuing operations.
IAS 36 Impairment of Assets seeks to ensure that an entitys assets are not carried at more than
their recoverable amount. With the exception of goodwill and certain intangible assets for which

the impairment test is required, companies are required to conduct the impairment test if there is
an indication of a possible loss.
IAS 8 - Changes in accounting estimates, preparation of financial statements may involve the use
of accounting estimates in determining the carrying amounts of assets & liabilities and the
associated expense or income for the period where such amounts cannot be measured precisely.
Examples of accounting estimates include the following:
Valuation of land where it is accounted for at revalued cost
Impairment of non-current assets
Useful lives of non-current assets
Pattern of economic benefits expected to be received from non-current assets for
calculating depreciation
Financial Accounting
Is important to all businesses, it is a way for them to keep records of all transactions that
occur in the business during a specified timeframe, usually a year. By using double entry
accounting each transaction will affect at least two accounts. Financial accounting provides a
look into the business and will tell outsiders how the company is doing financially. Since
accounting is regulated by standards and GAAP, the financial statements provide the company,
internal and external users comparability from one company to another. By analyzing financial
information you will be able to see where the company is, and make the best decisions that will
further the business and profitability.
Accounting for Patents
Only intangible assets that have been acquired are reported on the balance sheet and reported at
their purchase price. A company doesn't report internally developed intangible assets on the
balance sheet.
To be able to capitalize an asset it must have a useful life that extends beyond the current
year, the asset must be used to conduct business, and provide the company with a benefit. The
costs you pay to use a trademark, copyright, patent, or similar intellectual property can be
amortized (Joyner).

A business will use amortization for definite life intangibles such as a patent. This
process will reduce the intangible assets value on the balance sheet in equal annual installments
over the life of the asset and transfers each amount to an amortization expense account on the
income statement. The method used and the amount of amortization expense is presented in the
financials. Annual amortization reduces net income on the income statement which also reduces
retained earnings in the stockholders equity section of the balance sheet. R&D can be found on
the income statement as an operating expense in the current year. R&D expenses are subtracted
from revenues every year directly. Therefore, R&D spending is treated as an expense rather than
as an investment (YCharts). You cannot capitalize R&D costs on the balance sheet as an asset.
Impairment testing should be done on an asset, if there is a loss, it will reduce income in the
income statement and reduce total assets on the balance sheet (Boundless, 2014). Research and
development (R&D) costs that are required to develop the idea being patented are not included in
the in the cost of the patent but are expensed.

Debit
Patent (Bal)

Credit
xxx
Cash (Bal)

xxx

Cash (Bal)

xxx

R&D (IS) exp xxx

Amortization xxx
Patent (BS)

Patent Exp (IS) xxx

Loss Impairment xxx
Patent (IS)

Accum Impairment Losses xxx

(BS)

Patent (BS) xxx

To show decrease in value

Recommendation
XYZ Research Company has been in business since 2010, and is unsure whether the
company has been accounting for patent costs correctly. They have been expensing all the costs
to obtain a patent. The client has come to our firm so we can research and improve the
accounting for these costs and to ensure that it is in compliance with current accounting rules and
regulations.
After review of accounting authorities and other data regarding the treatment of these
costs, I have come to the conclusion that some changes should be made. A patent is; rights that
have been granted by the government to the inventor for a particular amount of time to stop
others from using, making, or selling the idea for a limited time. Patents have a legal life of 20
years. An intangible asset does not have any monetary value and are without physical substance.
Costs incurred to develop and maintain an internally developed intangible asset are recognized as
an expense when incurred (IASPLUS.com). Intangibles with a definite life are amortized to
expense and cant exceed 40 years. Research and development (R&D) costs required to develop
the idea being patented are not included in the in the cost of the patent. You can elect to amortize
your research and development costs, deduct them as current business expenses, or treat them as a
capital expense and write them off over a 10-year period under IRS rules. If you elect to treat the costs as
a capital expense, deduct the costs in equal amounts over 60 months or more. The amortization period
begins the month you first receive an economic benefit from these costs. XYZs patents will have a
limited useful life and I will advise them to determine the useful life for any future or current patents.

I recommend that XYZ Company recognize Research and Development costs as a current
expense. XYZ is developing their own product that will result in obtaining a patent; any material
and labor used will be an expense to the company and will be recorded as incurred, which may

not be the same period in which the related cash is paid. It is often better to take the hit for this type
of expenditure up front against your profits. Then, when your company starts to sell the product resulting
from this research, you can show profitability then, because you have taken account of the R & D already.

Once the patent is granted only the cost for registration, and legal fees are included and recorded
as the cost of the patent. The Straight line method for amortization is calculated by using the
cost of the patent and dividing by the years of useful life. This timeframe varies depending on
how long the company will receive some monetary benefit out of the patent and the length of
time remaining on the patent registration. Impairment testing is not required but would be
needed if there are changes in the industry or market that would affect the value of the intangible
asset or in this case any patents. An intangible assets annual amortization expense reduces its
value on the balance sheet, which reduces the amount of total assets in the assets section of the
balance sheet. This occurs until the end of the intangible assets useful life. Amortization expense
reduces net income on the income statement.
Accountants for XYZ Company will need to review the rules and regulations that have
been established by the FASB and GAAP, paying close attention to those mentioned in this
memo. Since XYZ Research Company has not been recording the Research and Development
costs, which is an omission error; this will be corrected by a journal entry between the accounts
affected. Now that the cost of the patents will be amortized over its useful life, and this has never been
recorded in the financial reports it will be handled as a c hanges in accounting estimates. This must be

accounted for in the financial statements, and incorporated in the accounting period in which the
estimates are revised. Therefore, carrying amounts of assets, and any associated expense and
gains are adjusted in the period of change in estimate (accounting-simplified.com).

With the accounting practices being changed, XYZ could be entitled to some tax benefits
if this is the case then the company will need to amend prior financial reports and file amended
tax return. I hope you find these recommendations helpful to your business.

Works Cited
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http://www.ehow.com/info_8079234_expenses-patent-accounting.html
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